Sean McGould is nearly three-quarters of the way toward achieving his goal: managing hedge fund-of-funds portfolios that invest only in hedge fund separate accounts. Declaring the use of separately managed accounts “one of our best investment ideas,” Mr. McGould — president and co-chief investment officer of Lighthouse Investment Partners LLC — and his colleagues have spent the past five years persuading hedge fund managers to offer them “a fund of one,” rather than restricting investors to investing in pooled fund vehicles. So far, they've persuaded 80 of the 110 hedge fund managers that underlie the firm's hedge funds of funds to create separate accounts. This gives the investment staff at Lighthouse Partners a fully transparent view of the holdings of hedge fund portfolios as well as control over liquidity.
Mr. McGould's insistence on knowing precisely the holdings in Lighthouse Partners' hedge funds is a throwback to his earliest days in the investment management business. He was responsible for investing company money in external hedge funds as director of the outside trader investment program for Trout Trading Management Co. Ltd., Hamilton, Bermuda. In 1996, he became CIO of Asset Management Advisors (now GenSpring Family Offices) in Palm Beach, Fla. Mr. McGould struck out on his own in 1998, founding Lighthouse Partners in Palm Beach Gardens, Fla. Lighthouse Partners was acquired by HFA Holdings Ltd., Sydney, in 2008 and operates independently under its own name. Lighthouse Partners managed money for friends and family in its first year. In 1999, it began accepting external client money, mostly from high-net-worth individuals. Today, 75% of the firm's $5 billion under management comes from institutional investors.
Mr. McGould spoke candidly about the excitement — and frustrations — of ushering hedge fund managers into a new way of accommodating investors.
How did Lighthouse Partners break into institutional asset management? In about 2001, the institutional appetite for hedge fund and fund-of-funds investment started to pick up, thanks to the bear market in equities. Prior to that, everybody was making 80% in the Nasdaq and no one needed hedge funds. It really was a high-net-worth marketplace.
What started to happen was that the families that were involved (with) foundations or whose companies had pension funds also started to invest in hedge funds of funds, and that also helped to increase the institutional appeal of hedge funds.
But it was the institutional investment consultants that really drove the growth of institutional investment for us. A Swiss institutional investor's $20 million investment in our fund in 2000 was extremely helpful in attracting other institutions. We started winning foundation and college endowment mandates through consultants after that and from there, began working our way into the pension fund community and to other types of corporate investors.
Lighthouse is not always the first hedge fund-of-funds manager on a consultant's list. No, that's true and I don't think we ever will be, except as it relates to managed accounts. There isn't anyone else at our size that's offering hedge fund-of-funds managed-account investment.
We have five or six really solid consulting relationships, but it's not across the board. We're not in New York. We have offices in New York, Chicago, London and Hong Kong, but we're not headquartered in New York.
Do consultants really care that you aren't based in New York? Some of them do.
Why did you become so focused on managed accounts? It was really just a simple idea at the bottom of all this: We want to know what we own and where our assets are.
I got tired of going home every day not knowing how we did. As dumb as that sounds, we'd been investing at that time for a decade. We don't compete with our hedge fund managers. We're not prop trading internally, we're not taking their ideas and doing something different with them. We're professional investors; we should know, every day, exactly how we're doing and what we're invested in.
When did you start moving to managed accounts? How are they structured? Five years ago, we started converting hedge fund pooled investments to managed accounts.
We offer commingled hedge funds of funds for investors, but rather than invest in pooled vehicles offered by the underlying hedge fund managers, we set up separate accounts. The manager trades the assets, but we own them ... we know exactly where the assets are, what they are invested in and how much leverage is being employed on those assets.
Now it's possible to look at the portfolio holdings daily. And that makes our investment approach more like that of a multistrategy hedge fund than a fund of funds because we have the data and can look at what managers own and construct more diversified portfolios.
Does someone really review all of the hedge fund portfolios daily? Yes. Definitely.
What progress has Lighthouse made in converting its hedge fund managers to separate accounts? We still are invested in some pooled hedge funds. We figured it would take about five years to convert the whole portfolio ... and we're a long way down that path. We have six funds of funds that are completely invested in hedge fund separate accounts and another six funds that still invest in some pooled funds, but we're converting them.
Is there a downside to managed accounts? The biggest negative is selection bias. Some hedge fund managers won't do managed accounts. There are some managers out there that I'd love to invest with that won't give us a managed account. There are some managers that we invest in now, like Greenlight Capital Management Inc., our second-best investment ever, that just isn't going to do a separate account for us. But that's OK.
We have to overcome that selection bias by having performance in the hedge fund of funds that's as good as or better than our competitors.
Have you had to terminate some managers because they wouldn't let you move to a managed account? Yes, especially in the long/short equity area. We terminated some firms, not because they were bad managers, but there's a high hurdle. If we are looking at 10 value-oriented long/short equity managers and the one we happen to be invested right now doesn't want to do a managed account, we're really upfront with them and say, 'Look, we think you're really good, probably one of the top 20 in the world at what you do, but we've got 10 others that will do exactly what we want.'
We've actually had a few come back and say they'll do a managed account. We don't put a gun to anyone's head. We understand; not everyone wants to do this.
Do you expect that many or most institutional investors will move to managed accounts? No. I think that perhaps one-quarter of institutional investors will move to managed accounts. I don't think managed accounts will dominate the market.